ETFdb.com is recommending a new short position for the month ahead. This short recommendation is based around preparing for a potential pullback in a high-beta corner of the market that appears vulnerable after a nearly-vertical recovery since the December 2018 lows. Below, we outline our investment thesis and outlook for the new recommendation.
This position is motivated by a momentum-driven sector facing major overhead resistance that has yet to be conquered even after multiple attempts all throughout last year. Given the sharp recovery seen in this sector, we feel that profit taking pressures are rising especially as we approach a significant long-term resistance level.
Furthermore, market-wide selling pressures alone can drag down this sector given the magnitude of its rebound in recent weeks.
The new short recommendation is based around:
Technology Equities ETF that is up over 18% year-to-date; and over 100% in the last 3-years This ETF has seen heavy outflows over the past month totaling $110M, while its year-to-date outflows are slightly less discouraging at just over $30M The fund is extremely concentrated as the top ten holdings from a portfolio of nearly 25 securities account for almost two-thirds of the total assets under management In terms of exposure, this ETF is dominated by well-known Large-Cap securities from the Technology sector
Check out our previous buy recommendation here
For this edition, we are recommending a short position in VanEck Vectors Semiconductor ETF (SMH A-), which had a closing price of $104.03 as of Wednesday, March 13.
The main thesis behind this short recommendation is straightforward: what goes up, must come down, at least in the short-term that is. What we mean here is that this pick is a classic “mean reversion” play, where we anticipate a return to more “normal levels” after a period of outsized gains. Put another way, given the sheer magnitude of the recovery this ETF has staged since the December lows, its long overdue for a meaningful pullback.
There are two other fundamental factors behind this short pick. First and foremost, the Semiconductor industry is known for its high-beta nature; meaning that it will usually move in tandem with, and with greater magnitude, than the broad equity indexes. Given that the broad equity indexes have also been riding along a V-shape recovery, it’s likely that market-wide profit-taking pressures are building up.
Featuring a beta of 1.24, the Semi’s ETF can come down just as fast as it went up, especially if the whole market heads south for a few days.
The other fundamental reason behind shorting Semi’s amid the rebound is that this industry has lost its leadership status. Up until the market meltdown in Q4 of last year, Semiconductors were the clear-cut leader of the market; the group marched higher and higher as major equity indexes lagged behind.
However, today we’re observing a changing dynamic; and more specifically, we’re seeing that Semiconductors are lagging behind their Software-focused peers. What’s the reason behind this rotation? One factor we can put our finger on is slowing earnings growth for the once-Hot semi’s; just look at the last few lackluster earnings from former favorites like Nvidia (NVDA), Intel (INTC), and Advanced Micro Devices Inc. (AMD). We’re not saying the growth story is dead for these names, or the industry, but the expectations have risen to a level where disappointment appears more likely than continued surprises to the upside.
In light of their recent rally coupled with slowing earnings growth, we are observing Semi’s pass along their leadership torch to rising Software names. Furthermore, Semi’s are nearing a major resistance level that they failed to summitt multiple times last year; by comparison, iShares Expanded Tech-Software ETF (IGV B+) made fresh all-time highs at the start of March and is poised to keep climbing into uncharted territory.
Check out our whole list of semiconductor industry ETFs here.
Let’s move to the technical setup of the VanEck Vectors Semiconductor ETF (SMH A-) and take a closer look at the stiff resistance level we keep mentioning. Consider SMH’s daily one-year chart below:
From an intermediate-term perspective, this ETF is trading just above a recently declining 100-day moving average (red line) which suggests that its long-term trend is a bit undecided. From a bearish perspective, SMH is nearing the $110 price level which it failed to summit after more than half a dozen attempts throughout 2018. This is an important level that has yet to be breached. From a short-term perspective, SMH is showing compelling signs of an uptrend underway. This ETF is trading above its sharply rising 20-day moving average (green line) since the start of this year. Taking a short position in rising security can prove disastrous, so we’re waiting for a failed breakout, or the start of a pullback before initiating.
The recent rally in Semi’s has been nothing short of spectacular. However, because the ETF is nearing a major resistance level that it failed to summit all throughout 2018, we are preparing to take a short position in anticipation of a pullback as it nears $110 a share. Given the dominant uptrend in the short-term however, we advise closing out any shorts if SMH settled about $107-$108 depending on your risk tolerance.
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The Bottom Line
We are recommending a short position in the Semiconductors ETF for two reasons. From a fundamental perspective, this once-hot market leader has seeing earnings growth expectations cool off and, in the meantime, has given up leadership to its Software peers. From a technical perspective, SMH is slowly but surely approaching a significant resistance level that stood unbreeched for all of 2018.
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Disclosure: No positions at time of writing.